Restrictive covenants are clauses in contracts that limit the actions of a party during and after the term of the contract. These covenants are crucial in protecting business interests such as confidential information, client relationships, and trade secrets. They are commonly found in both employment contracts and commercial agreements, but their enforceability and scope can differ significantly between these two contexts.
Employment contracts
Types of restrictive covenants
In employment contracts, restrictive covenants are designed to protect the employer's business interests by preventing former employees from engaging in activities that could harm the business. Common types include:
Non-competition clauses: Prevent employees from working for competitors or starting a competing business for a specified period after leaving the company.
Non-solicitation clauses: Restrict former employees from soliciting the employer’s clients or employees.
Non-dealing clauses: Prohibit former employees from dealing with the employer’s clients, even if the client initiates the contact.
Confidentiality agreements: Ensure that former employees do not disclose sensitive business information.
Enforceability
For a restrictive covenant in an employment contract to be enforceable, it must be reasonable in scope, duration, and geographical reach, and it must protect a legitimate business interest. Courts will not enforce overly broad covenants that unfairly restrict an individual’s ability to work. The case of Square Global Limited v Leonard highlights that non-competition clauses must go beyond merely protecting legitimate business interests to be enforceable.
Commercial agreements
Types of restrictive covenants
In commercial agreements, such as share purchase agreements (SPAs) and shareholder agreements, restrictive covenants are used to protect the business interests of the parties involved. These covenants often include:
Non-compete clauses: Prevent parties from engaging in business activities that compete with the business being sold or invested in.
Non-solicitation clauses: Restrict parties from soliciting clients, suppliers, or employees of the business.
Confidentiality agreements: Ensure that sensitive business information is not disclosed.
Enforceability
Restrictive covenants in commercial agreements are generally more readily enforceable compared to those in employment contracts. This is because they do not typically attract the restraint of trade principle and are often seen as necessary to protect the legitimate business interests of the parties involved. The case of Literacy Capital Plc v Webb illustrates that even in commercial agreements, the enforceability of restrictive covenants can be challenged if they are deemed excessively broad or unnecessary.
Key differences
Scope and duration
Employment contracts: Restrictive covenants must be narrowly tailored to protect specific business interests and are often limited in duration to six to twelve months. Courts scrutinise these covenants closely to ensure they do not unfairly restrict an employee’s ability to find new employment.
Commercial agreements: These covenants can be broader in scope and longer in duration, as they are designed to protect significant business interests in transactions such as the sale of a business. Courts are generally more lenient in enforcing these covenants, provided they are reasonable and necessary to protect the business interests involved.
Legal standards
Employment contracts: The burden of proof is on the employer to show that the restrictive covenant is necessary to protect a legitimate business interest and is reasonable in scope and duration.
Commercial agreements: The burden of proof is less onerous, and the courts are more likely to enforce these covenants if they are part of a negotiated commercial transaction between parties with relatively equal bargaining power.
Practical steps for employers
Drafting and reviewing covenants
Tailor covenants to specific roles: Ensure that restrictive covenants are tailored to the specific role and responsibilities of the employee or party involved. Avoid a one-size-fits-all approach.
Periodic review: Regularly review and update restrictive covenants to ensure they remain relevant and enforceable, especially when an employee’s role changes or in the context of evolving business relationships.
Enforcement
Prompt action: Act swiftly if you suspect a breach of a restrictive covenant. Delays can weaken your case and reduce the likelihood of obtaining an injunction.
Evidence gathering: Collect evidence of the breach, such as emails, phone records, and witness statements, to support your case in court.
Additional considerations
Consideration: Ensure that there is adequate consideration for the restrictive covenant, especially when introducing new covenants during employment. This could be in the form of a pay rise, bonus, or other benefits.
Legal advice: Seek expert legal advice when drafting, reviewing, and enforcing restrictive covenants to ensure they are reasonable and enforceable.
By understanding the differences between restrictive covenants in employment contracts and commercial agreements, employers can better protect their business interests and navigate the complexities of these legal provisions.
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